Pundits no longer confidently assert that the massive
US trade deficit is good for the economy, because it
puts money in foreign hands to buy US exports and create
jobs for Americans.

Some pundits are even beginning to realize that
“lower-priced foreign goods” are not all that cheap
when the price is the loss of
high-paying US jobs.

But pundits still believe that free trade is somehow
going to bail America out and create new industries and
high-value-added jobs to replace the ones lost to
offshore production and outsourcing (and, I should add,
to competition from Japanese industrial policy).

Sooner or later pundits will have to face the fact
that the conditions upon which the case for free trade
is based simply no longer exist.

Free trade is based on the principle of
comparative advantage. For comparative advantage to
operate, two conditions are required: (1) a country`s
factors of production must seek comparative advantage
within the country and not move to absolute advantage
abroad, and (2) countries must have different relative
costs of producing different goods.

When free trade theory
originated two centuries ago,
climate and natural resources were important
components of GDP. Climate and natural resources could
not migrate, and countries` different climates and
resource endowments meant that relative costs varied
among countries.

In today`s modern economies, production is based
primarily on acquired knowledge. Modern production
functions operate the same regardless of their location.
There is no necessary reason for the relative costs of
producing manufactured goods to vary from one country to
another. Only the absolute costs vary, with the
advantage going to countries with
large excess supplies of labor.

Economists and pundits mistake offshore production
and outsourcing for trade, whereas in fact they are
merely the substitution of cheap foreign labor for
expensive first world labor.

It is nonsense for economists and pundits to claim
that the US benefits from the loss of jobs, capital and
technology when economic theory tells us that all three
are needed for economic development.

Gomory and Baumol show that conflict is inherent in
international trade. In some cases free trade can be
mutually beneficial. In other cases, one country gains
at the expense of another. In some cases trade is worse
than no trade. The authors demonstrate that in no case
can all trading countries achieve their individually
best outcomes.

Many modern industries are characterized by
increasing returns, which means that countries with
industrial policies can target industries, wrest them
away from free trading countries, achieve a monopoly and
retain the industry indefinitely.

Gomory and Baumol
remind us that the issue is not whether companies or
individual consumers benefit from free trade, but
whether the country overall benefits. Specific
corporations and consumers can benefit from offshore
production and outsourcing, while the country as a whole
loses occupations, industries, production capability and
GDP.

A country that produces a large share of the world`s
goods “has much to consume and much to trade. It becomes
a high-wage, high-consumption country. This beneficial
effect of being the producer of a large proportion of
the world`s tradable industries can be very
substantial.” The greater the share of world income a
country can achieve, the higher the wages of its
workers.

A country whose policymakers are under the illusion
that free trade is uniformly beneficial is likely to
find itself blindsided in the competition for important
industries and occupations.

In today`s world, the interest of multinational
corporations can easily diverge from the interests of
their home countries. When, in pursuit of lowest cost,
multinationals move production for their home markets
abroad, they move GDP abroad by turning domestic
production into imports. A country that produces abroad
for its home consumption will never close its trade
deficit.

Perhaps Gomory and Baumol will wake up policymakers
before the US becomes a mere low wage assembler of
foreign made inputs.

Paul
Craig Roberts was Associate Editor of the WSJ editorial
page, 1978-80, and columnist for “Political Economy.”
During 1981-82 he was Assistant Secretary of the
Treasury for Economic Policy. He is the author of